What is operating profit? It shows how much money your business makes from its core activities after you take away direct costs and operating expenses. Sales alone do not tell the full story. Instead, operating profit helps you understand how well the business performs before interest and tax enter the picture. In this episode, we explain what operating profit means, how to calculate it, why it matters, and how operating margin helps measure business performance.

About this episode

Profit gives business owners one of the most useful ways to measure performance. However, the word profit can mean different things depending on which number appears in the accounts.

Here, the focus is operating profit. We look at what operating profit means, how the calculation works, and why it gives a clearer view of how well the core business performs.

You may also come across related terms such as net profit, EBIT and PBIT. These terms often appear in accounts, reports and business conversations, so understanding them helps you read your numbers with more confidence.

Why operating profit matters

Operating profit helps you judge business performance before interest and tax enter the picture.

Sales can look strong, but they do not show whether the business runs efficiently. Operating profit shows what remains after the business covers the direct costs of sales and the operating expenses needed to keep going.

Because of this, operating profit supports budgeting, planning, management accounts and better decisions about how the business uses its resources.

For the wider profit foundation, see What Is Profit? Gross Profit and Net Profit Explained.

What is operating profit?

Operating profit is the profit made from the main activities of the business.

The calculation starts with turnover, sales or revenue. Next, you take away direct costs, also known as cost of sales. After that, you deduct operating expenses such as rent, admin, marketing, bookkeeping, staff costs and other running costs.

That leaves operating profit. It shows the profit generated before interest and tax are added to the story.

Other names for operating profit

Operating profit can appear under different names.

• Operating profit: the main term used in this episode.
• Net profit: a term sometimes used in a similar way, depending on context.
• EBIT: earnings before interest and tax.
• PBIT: profit before interest and tax.

These terms are closely linked, but reports and financial statements may use them differently. Therefore, always check which costs have already been deducted and which ones still sit outside the calculation.

How to calculate operating profit

The basic calculation is:

Turnover minus cost of sales minus operating expenses equals operating profit.

In plain English, start with what the business sells. Then take away the direct costs needed to make those sales. Finally, take away the operating costs needed to run the business.

That gives you the profit from core business operations.

Artist example: calculating operating profit

The episode uses an artist example to make the calculation easier to follow.

Imagine an artist sells works of art during the year and makes £60,000 in turnover.

The artist spends £20,000 on direct costs such as paints and canvases. That leaves £40,000 of gross profit.

On top of that, the artist spends £20,000 on operating expenses such as studio rent, admin support, marketing and bookkeeping.

So the operating profit is £40,000 gross profit minus £20,000 operating expenses. That leaves £20,000 operating profit.

This also shows how operating profit differs from gross profit. For more on that earlier layer of profit, see Gross Profit Explained: How to Calculate Gross Profit, Margin and Markup.

Restaurant example: another operating profit calculation

The same idea applies to other business types.

For example, a restaurant may generate £100,000 in sales. It may spend £40,000 on food and other direct purchases. That leaves £60,000 of gross profit.

If the restaurant then spends £20,000 on operating costs such as rent, marketing and staff wages, the operating profit is £40,000.

The shape of the business may change, but the principle stays the same. Operating profit shows how much profit remains after direct costs and operating expenses come out.

Operating profit as a business benchmark

Operating profit works well as a benchmark because it focuses on the core business.

It helps show how efficiently the business is managed. It also helps you review how well resources are being used, how tightly operating costs are controlled and whether the business model is strong enough.

If turnover rises and operating costs stay broadly the same, operating profit should improve. However, if turnover falls while operating costs stay in place, operating profit can drop quickly.

That makes operating profit useful for planning, forecasting and stress-testing business performance.

What is operating margin?

You can also show operating profit as a percentage. This is called operating margin.

Operating margin compares operating profit with turnover. It helps you understand how much operating profit comes from each pound of sales.

In the artist example, turnover is £60,000 and operating profit is £20,000. When you divide £20,000 by £60,000, the operating margin comes to around 33%.

Both the money figure and the percentage are useful. The money figure shows how much operating profit the business has made. Meanwhile, the percentage helps you compare performance over time or across different parts of the business.

For a related performance-measurement episode, see Using Financial Ratios in Business.

How operating profit helps decision-making

Operating profit helps business owners ask better questions.

• Are sales high enough to support the business?
• Are direct costs under control?
• Are operating expenses too high?
• Is the business becoming more or less efficient?
• How much profit comes from core trading activity?
• What happens if turnover drops?
• Can the business afford to invest, grow or take on more costs?

These questions move business decisions away from guesswork and towards clearer financial understanding.

Operating profit and financial statements

Operating profit also helps when you read financial statements.

It usually sits below gross profit and above interest and tax. That position matters because it shows the profit made from business operations before financing costs and tax come in.

As a result, operating profit makes it easier to judge whether the business itself is performing well, separate from how it is financed or taxed.

For help with the wider picture, see Understanding Your Financial Statements.

FAQs about what is operating profit

What is operating profit?

Operating profit is the profit made from the core activities of a business after direct costs and operating expenses come out, but before interest and tax are included.

How do you calculate operating profit?

You calculate operating profit by taking turnover, subtracting cost of sales or direct costs, and then subtracting operating expenses.

Is operating profit the same as gross profit?

No. Gross profit is sales minus direct costs. Operating profit goes one step further because it also takes away operating expenses such as rent, admin, marketing and other running costs.

Is operating profit the same as EBIT?

Operating profit is closely linked to EBIT, which means earnings before interest and tax. In many business contexts, people use them in a similar way, but you should always check what the calculation includes.

Why is operating profit important?

Operating profit matters because it shows how well the core business performs. It also supports budgeting, planning, cost control, forecasting and better decision-making.

Episode Timecodes

• 00:00 – Profit as a business performance measure
• 00:00 – What the episode covers: operating profit, calculation and importance
• 01:32 – Operating profit, net profit, EBIT and PBIT
• 02:15 – How operating profit is calculated
• 02:46 – Artist example introduced
• 03:21 – £60,000 turnover, direct costs and operating expenses
• 04:06 – Restaurant example and why operating profit is useful
• 04:51 – Turnover changes and operating profit movement
• 05:38 – Operating margin percentage explained
• 06:19 – Final wrap-up

Related episodes

• Gross Profit Explained: How to Calculate Gross Profit, Margin and Markup
• What Is Profit? Gross Profit and Net Profit Explained
• Understanding Your Financial Statements

Key takeaway

Operating profit shows how much profit your business makes from its core activity after direct costs and operating expenses come out. It looks beyond sales and shows how efficiently the business operates.

Once you understand operating profit and operating margin, you can make better decisions about costs, pricing, budgeting, planning and future growth.

Plan it, Do it, Profit.

Operating profit helps show how well the core business is really performing.

Further Support

The I Hate Numbers podcast helps business owners understand profit, operating costs, gross margin, pricing, cash flow, tax and financial performance in a practical way. We simplify business finance so you can make better decisions and feel more confident with your numbers.

If you need help understanding operating profit, reviewing costs, improving margins or planning business performance more clearly, you can contact us for an initial chat.

You can also use the free online business calculators to support your profit and pricing decisions.

For more practical finance and tax support, visit the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

📘 Book

https://www.ihatenumbers.co.uk/i-hate-numbers-book/

🎧 Podcast

https://www.ihatenumbers.co.uk/i-hate-numbers-podcast/

🌐 Website

https://www.ihatenumbers.co.uk

Profits is used widely as a performance measure. It measures how well you are performing in your business and what profit, in particular, operating profit is used very widely. In this broadcast, I'm going to explain what operating profit is, I’m going to explain how we calculate it, and I'm also going to look at why it's such an important metric, an important measure that we as business owners should understand and use in our business to power it forward.

You're listening to the I Hate Numbers podcast with Mahmood Reza. The I Hate Numbers Podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

Hi folks. My name is Mahmood. I am the founder director of the accounting firm I Hate Numbers and also of the financial storytelling platform Numbers Know How. My mission over the last 27 plus years has always been to help business owners make more profit, increase their financial awareness, help them win more battles than they lose for what goes on between the ears, help them save time, save tax and have the businesses they aspire to do. That's a pretty good objective in my eyes. Let's crack on with the podcast.

Now, first of all, let's have a look at the idea of operating profit. And the first thing we need to get to grips with is there a multitude of terms you are likely to encounter for what operating profit is. You may come across the term net profit. You may also come across the term EBIT and PBIT, two acronyms which stand for as follows. EBIT represents earnings before interest and tax, and PBIT is profits before interest and tax. As a side note folks, by the way, earnings is that umbrella term that means profits. So we first of all got four different terms that you're likely to encounter. Operating profit, also called net profit, also called EBIT and also called PBIT.

Having gone through that variety of terms that we can use, let's have a think about how we calculate it. Now, the idea of operating profit is we're comparing effectively three numbers. We're looking at the value of what we sell as a business, as an organisation, what we call turnover. We then take off two groups of costs. We first will take off that group of costs, which are called cost of sales or direct costs. More of that in a few moments. And then lastly, we've deduct all the operating expenses of our business.

Let's compare and contrast two examples. An artist - put yourself in the shoes of an artist making their living, making their business income through selling works of art. They charge for those works of art and they have to spend money on paints, on canvases, and they also spend money on renting a studio. Having an admin person helps them set up a studio also money spent on marketing, money spent on bookkeeping. Let's throw some numbers to reinforce that. Now, our artists, in this example, sells works of art during the course of the year and sells them for a magnificent £60,000.

Substitute the currency of your choice. They also spend £20,000 on paints, on canvases on which to display their talent, and they also spend another £20,000 on the rent of the studio, the admin, the support, the marketing, et cetera. Now, out of those three numbers, the gross profit our artist is earning is the £60,000 worth of turnover, less than £20,000 worth of paints and canvases. That gives them what's called a gross profit of £40,000. Out of that, £40,000, they then have to cover the admin, the marketing, the rent of the studio, and that gives them 40, less 20, another £20,000. And the operating profit from that artist is £20,000.

Doesn't matter the shape of the business. If we looked at a restaurant tour selling the food, taken to count the outside catering they might be doing, they take off the cost of the food. Let's say it's £100,000 worth of sales, it's £40,000 worth of food purchases, etc. That gives you a 60,000 pound gross profit. The cost of renting the restaurant, the marketing, the staff wages, or another called 20,000. And that gives them a 40,000 pound operating profit. Now, having got that figure, what uses it to us? Well, it serves as a useful benchmark. It also serves as a very good indicator to judge the managerial competence, the efficiency of us and our management team of running the business. What's the core level of profits?

We know that if we manage to sell more our rent, our running costs will stay the same and operating profit is going to go that way. If, unfortunately, we catch a chill and turnover drops, the underlying operating costs will remain the same and the operating profit will decline downwards. Couple more things just to throw into the mix, folks. We could, if we wish to, and it's really a useful way of doing it, express our operating profit in proportion or percentage terms. So if we take the example of our artist, we had £60,000 worth of sales, we had £40,000 worth of paints, rent, etc. That gave us a 200 pound operating profit. If we divide 20 by 60 and times it by 100, that gives us 33%.

And that is the operating margin percentage that we're earning. If we sell more, then the operating percentage goes up, and if we sell less, the operating percentage goes down. So operating profit can be expressed in both currency form, dollars, pounds, take your pick, or in percentage terms. Both of them are really useful. Folks, I hope you found this video useful. I'd love it if you give some comments, tell me what you think. Do you calculate the operating profit for your business? Do you know what it is? If not, give it a go. Check out the show notes, and I'll give you a link to some further resources that will help you in your business. Until next week, folks, happy calculating.

We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.